Pricing Power Is Back, Inflation Isn't

Continuing overcapacity and the Fed's steady hand minimize the potential for an across-the-board return of sticker shock

By Rich Miller

There's a whiff of inflation in the air. Import prices are up, courtesy of the weak dollar. Producer prices are surging -- in November they rose at a year-over-year rate of 5.1%, their fastest clip in 15 years. Even at the consumer level, where price competition is keenest, some companies are finding that they can pass on their higher costs to their customers. On Jan. 1, Whirlpool (WHR ), Electrolux (ELUX ), Maytag (MYG ), and General Electric (GE ) each will jack up big-ticket appliance prices 5% to 10% to cover their higher bills for steel and other materials. That's the steepest hike in at least five years.

What's going on? It's all about supply and demand. Demand is being fueled by a global economic recovery and a still-accommodating monetary policy by the Federal Reserve. Supply, meanwhile, is getting tighter thanks to industry consolidation and a continued reluctance by companies to add capacity. The weak dollar is also playing a large role, says Standard & Poor's Chief Economist David Wyss, because it curbs foreign competition. Put it all together and it's hardly surprising that price pressures are growing.


  Indeed, after years of having to swallow higher commodity prices and other rising costs, many companies are finding they are finally able to pass those price hikes along to customers for the first time since the 2001 recession. In some cases they're tacking on more. Dow Chemical (DOW ), for one, raised its average selling prices in the third quarter by 19% from a year earlier, more than making up for the jump in its energy costs. With supplies tight -- Dow is running its plants at 90% of capacity -- corporate customers had little choice but to accept the price hikes. "Pricing power is returning to the producers," says CEO Andrew N. Liveris. "The market is robust."

Steel companies are also enjoying more pricing leverage. Stainless steel prices are up 80% since January, 2003, while carbon steel prices have doubled in 2004. "There has only been one other period, which was World War I, when there's ever been a price spike as great as this year," notes Maytag CFO George Moore, whose company is a big buyer of steel.

Besides global demand, steelmakers are benefiting from tighter supply from industry consolidation. In just the last two years, U.S. Steel (X ) gobbled up National Steel, while International Steel Group consolidated LTV, Bethlehem Steel, and Weirton Steel, and Nucor (NUE ) acquired Birmingham Steel and Trico Steel.

And that's hardly the only industry undergoing consolidation, as a slew of high-profile mergers over the past month shows. Deals include Oracle's (ORCL ) purchase of PeopleSoft (PSFT ) and Sprint's (FON ) pending linkup with Nextel (NXTL ) Communications, to name just a few.


  Prices are also on the rise in service industries. Tighter supplies are helping the travel business recover pricing power after several rough years. Hotel construction slowed dramatically over the past three years, to an average of 80,000 new rooms, half the level of 1998, according to PricewaterhouseCoopers. With business travel beginning to pick up, that's enabling companies such as Hilton Hotels (HLN ) to boost rates. Hospitality consulting firms PKFConsulting and Torto Wheaton Research figure the average hotel room rate in the 50 largest U.S. markets will rise by 4.7% in 2005, to $102 per night.

So with prices bubbling up, is a burst of damaging inflation on the way? Probably not. Many industries, still saddled with excess capacity, can't raise prices. The biggest: carmakers and airlines. And global growth is starting to cool, in part because of efforts by China to rein in growth. That's taking some edge off commodity prices, particularly oil, which has tumbled some $10 from its October peak.

Another moderating factor: On Dec. 14 the Fed raised rates by another quarter percentage point and signaled that more hikes are in store. As the Fed sticks to its plan, inflation shouldn't prove much of a problem.

With Michael Arndt in Chicago and Christopher Palmeri in Los Angeles

Miller is a senior writer for BusinessWeek in Washington

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